At first glance, it almost seems too good to be true. Genworth MI Canada Inc. (TSX:MIC) is a really cheap stock.
Shares of Canada’s largest private mortgage insurer currently trade hands at just over $32 each, which is flirting with a 52-week low. Yet the stock trades at just eight times earnings, and is expected to largely maintain earnings in 2015, when analysts have predicted the company will earn $3.92 per share. The current median price target from the handful of analysts that cover the company is $43 per share, which implies upside of some 30%.
Even from a price-to-book value metric, the company looks remarkably cheap. The book value as of September 30 was $35.96 per share, which means shares currently trade at a discount to book of more than 10%. Other financial metrics are solid as well. The company has great profit margins and also has a strong balance sheet with just $432 million worth of debt compared to $3.3 billion worth of equity, and most of that debt is offset by its $311 million worth of cash.
Plus, the company pays a terrific dividend with a current yield of 4.9%. With that yield comes some nice dividend growth too. When the company was spun off from its U.S. parent in 2009, it originally paid a $0.22 per share quarterly dividend. It’s currently $0.39 per share, which is annual growth of 12% annually.
In all my years of investing, I’ve realized a few things. One of them is there’s no such thing as a free lunch in the stock market. If there’s a stock trading at just 8x earnings, with an impressive dividend growth rate and a payout ratio of under 50%, the market anticipates some serious potential problems.
In the case of Genworth Mortgage Insurance, it’s obvious what the upcoming negative event could be, and that’s the implosion of Canada’s housing bubble.
But is it really as bad as it seems? Yes, Genworth does have some pretty significant exposure to Canada’s housing market, but it also has a big advantage too. The Canadian government has agreed that it will bear the cost of 90% of any future claims. So even though it has insured more than $300 billion worth of Canada’s real estate, it is really only responsible for 10% of that, or approximately $30 billion.
Thanks to premiums it has collected over the years, Genworth has an investment portfolio of more than $5.5 billion. If it is really only responsible for $30 billion of the $300 billion worth of real estate it insures, the company could survive a correction that completely wiped out 10% of homeowners.
No Canadian housing crash has ever been that bad. And remember, even in a declining market, the company would still likely be able to get something for real estate it was forced to foreclose upon.
It has one other thing going for it, and that’s a price increase that CMHC passed in May 2014. Since Genworth offers identical products as Canada’s default insurer, it was able to match CMHC’s prices immediately.
But that begs the question — if the products are identical, why exactly would a lender go with Genworth rather than CMHC? According to mortgage brokers I know, there are a couple of reasons. First, a lender will often submit a deal to Genworth after CMHC declines it, either because the borrower doesn’t meet qualifications or because the property is worth more than CMHC’s automated system thinks. Or, lenders will submit certain kinds of borrowers to Genworth in the first place, since it is known to be a little more lenient for applicants who are self-employed or are new to Canada.
There lies the crux of investing in Genworth. Although the company assures the market that it’s prepared for a housing crash, a meltdown like the one in the U.S. would not be a welcome event for equity holders. Even just the rumblings of a crash can send shares lower, as we’re seeing today.
On the other hand, if you’re a believer that Canada’s housing market will keep on chugging or experience that soft landing everyone is hoping for, Genworth is pretty attractively priced. For me, the risk is just too high. I’d pass on the stock.
